Princeton economics professor explains the economy — and gets it very, very wrong

Do you ever listen to Frank Caliendo? He’s a talented impressionist who spends much of his time ragging on John Madden. One of the things Caliendo claims that Madden does is restate his premise as if it’s a different conclusion, i.e., “Here’s a guy with mud on his jersey. When you mix dirt and water, then you’re going to end up with a muddy jersey.” You can get a flavor of what Caliendo does with Madden from this clip (and get nostalgic for George Bush, whom I miss greatly):

I thought of Caliendo’s take on Madden when I read Alan Blinder’s Wall Street Journal opinion piece supporting Keynesian economics. To appreciate fully the wonders of Blinder’s writing, you need to know that his mini bio explains that “Blinder, a professor of economics and public affairs at Princeton University, is a former vice chairman of the Federal Reserve.” In other words, he once had a hand in managing America’s money supply and is now molding America’s best and brightest young minds.

When I started reading the piece, given Blinder’s credential, I thought there was a real possibility that I’d suddenly realize that my decade long flirtation with conservativism was all wrong, and that I’d return to the Progressive fold with renewed fervor. After all, this guy promised to explain why the GOP is engaged in myth-making when it contends that Democratic jobs spending actually kills jobs, rather than creates jobs. I anticipated serious arguments about the effect of government money on the economy, complete with statistics about long-term job creation, the growth of business, and the decline of welfare rolls.

What I got, instead, was Madden-esque. Blinder carefully explained that government spending on jobs creates jobs because . . . get this! . . . it creates jobs.

As far as Blinder is concerned, a job is a job is a job, whether it’s government created or not. As long as the government isn’t raising taxes to create jobs, it’s a good thing:

The generic conservative view that government is “too big” in some abstract sense leads to a strong predisposition against spending. OK. But the question remains: How can the government destroy jobs by either hiring people directly or buying things from private companies? For example, how is it that public purchases of computers destroy jobs but private purchases of computers create them?

One possible answer is that the taxes necessary to pay for the government spending destroy more jobs than the spending creates. That’s a logical possibility, although it would require extremely inept choices of how to spend the money and how to raise the revenue. But tax-financed spending is not what’s at issue today. The current debate is about deficit spending: raising spending without raising taxes.

Blinder fails to take into consideration the fact that, as compared to the private sector, government jobs are excessively regulated; government responds slowly, if at all, to market forces; government jobs are less efficient producers and money generators than private sector jobs (indeed, many generate nothing but make-work); government programs, whether managed by the government or a third party are more prone to fraud than private sector work; and the massive heft of government perverts the market place, whether it is acting as a buyer or seller of jobs.

The end result of this excessive bureaucracy, inefficiency, and corruption is that government jobs ultimately shrink the fund of available money. Even if there’s an initial jobs bump (although the stimulus proved that to be a canard too, because there was no bump), in the long run money poured into government jobs shrinks the fund of available money in the private sector, lowering the amount of taxes the government takes in, thereby decreasing the government’s ability to create make-work jobs. It’s a downward, shrinking spiral.

Blinder is wearing blinders. His belief that a job is a job is a job is ignorant beyond belief, and ignores entirely the reality of government jobs programs. Eventually you end up with the old joke from the Soviet Union: The Soviet Union and a chain gang both have full employment — and both for the same reason.

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Book, Blinder reminds me of a fellow 20-something graduate student in my class who, upon passing her PhD orals, returned to the graduate student office to huffily proclaim, “Well, that’s over and now I can forget about all that nonsense I learned in class and start telling people the way it really is and should be”.

You, on the other hand, just provided a brilliant summation of economics that should put you at the head of line for an honorary PhD!

Bookworm: As far as Blinder is concerned, a job is a job is a job, whether it’s government created or not. As long as the government isn’t raising taxes to create jobs, it’s a good thing:

That is not Blinder’s position. Again, stimulus is temporary and only works when there is excess capacity and excess capital. Bookworm: Even if there’s an initial jobs bump (although the stimulus proved that to be a canard too, because there was no bump), …

Bookworm: in the long run money poured into government jobs shrinks the fund of available money in the private sector, lowering the amount of taxes the government takes in, thereby decreasing the government’s ability to create make-work jobs.

In the long run, government jobs do shrink the available funds for the private sector. But a stimulus is a temporary measure to put a floor on demand, and to ameliorate the worst aspects of the recession. In the long run, the deficits have to be addressed.

Charles Martel

“In the long run, government jobs do shrink the available funds for the private sector. But a stimulus is a temporary measure to put a floor on demand, and to ameliorate the worst aspects of the recession. In the long run, the deficits have to be addressed.”

1. What “worst aspects” of this recession have been ameliorated? Unemployment? Housing starts and sales? Gas prices? Food prices?

2. How will the deficits be addressed? Please, not your pro-forma “combination of spending cuts and taxes,” but an actual program—suggested cuts, suggested tax rates—that come from your own mind and not from what you steal off the Internet.

Charles Martel: 2. How will the deficits be addressed? Please, not your pro-forma “combination of spending cuts and taxes,” but an actual program—suggested cuts, suggested tax rates…
How will the deficits be addressed? Don’t know how they will be addressed in fact, as that is a decision for the Americans. Solutions are constrained by politics as much as by the economics. In any case, keep in mind that the U.S. had structural surpluses just a decade ago.

However, a reasonably progressive tax system, with fewer and less complex deductions, and with Clinton-era rates, would probably be reasonable. Most of the long term structural problems have to do with aging and health, so further reform of the system will be necessary. The U.S. government spends as much as the U.K. government on health care, but while the U.S. only covers the elderly and the disabled, the U.K. covers everyone. It’s doubtful the U.S. will move to single-payer, much less government-provided health care, but there is probably a mix of private insurance and subsidies that would work to bring down costs while providing universal coverage.

Bookworm cites Madden’s maddening semantics, but then falls into similar traps herself.

Let’s get the semantics out of the way. If you are a Marine, a public school teacher or the President of the US, you have a job. it is paying a salary, supporting a family, generating income that is poured back into the economy via consumption and investment/savings. To deny that the public sector creates jobs and economic activity, is to deny that some very large subsegment of jobs exist, which is a lie or a collosal demonstration of ignorance.

Now, Bookworm’s point is that public sector jobs, like the public sector itself, is inefficient in its allocation of resources and its cost versus the private sector. And there is much to establish this fact, which flows from the lower levels of competition that exist in the public sphere. But there are several aspects of the public private debate that go beyond a comparison of relative efficiency that also must be taken into account:

1. public jobs are a necessity in many areas–We do not want to rely on private armies for the defense of the US, or private fire departments for the protection of our homes, so we have public workers here. History has shown that mercenaries are less reliable than nationalistic soldiers, while our experience with private fire departments was not very positive, as competing groups would literally fight outside a blazing house rather than put it out. We need government and public jobs, like it or not. And no amount of conservative narrative writing can hide this fact.

2. public sector’s role complements the private sector–I’ve written much about externalities and the need for regulations and other public duties, which also makes the public sector a necessity. As just one example: Public education is a public good that is properly delivered at least in part by public teachers in publicly funded schools. While these schools have declined in the last several decades, the solution is to fix the public schools, not eliminate them.

3. public sector’s role during economic crisis is critical–as Keynes has clearly shown, and history has proven repeatedly, when the private sector is faced with inadequate demand, teh public sector needs to drive a recovery. Japan failed to learn this lesson after its crash in the late 80’s and hasn’t ever recovered. China and India and Vietnam have sparked rapid growth led by much greater government control of the economy, and they have been the fastest growing economies for years. The US has seen the benefits of government stimulus after the Depression. The classic counter-argument, which Book seems to make here, is that having the private sector do it is more efficient; however, that is a false choice. Private companies are not investing in the US because they don’t see adequate demand. The public sector needs to create that demand until the private sector gains confidence, first through consumption and then through capital investment. To argue that we have a crowding out of private investment because of public spending is ridiculous in light of the lack of corporate spending despite adequate cash on the corporate balance sheets.

4. debt to GDP levels have been higher before, and the market wants to see a long-term plan rather than short-term fix–addressing runaway defense spending and entitlements are critical, as is a restructuring of the tax code with higher rates to pay for what the vast majority of Americans demand from their government, and the bond markets will not punish the US if it can codify such a long-term sustainable plan. In the meantime, we need to recognize that the best way to address the fiscal crisis is to jump start normalized growth in the most effective way possible, and this includes stimulus. We have the debt headroom to do this, as long as the long-term overspending and undertaxing is addressed as well.

I also want to make an important clarification. Bookworm has a serious error in her piece. It is not merely Liberals who have adopted Keynesian theory. Conservatives have done so as well. Keynes wrote about generating demand through government action when monetary policy had been exhausted (i.e., when real rates were at 0%, which he called pushing on a string). In that situation Keynes recommended BOTH stimulative spending AND tax cuts to generate demand. Liberals have focused on primarily the former set of tools, while Conservatives have focused exclusively on the latter. But BOTH sets of solutions are from Keynes. To argue that the GOP’s continual mantra for tax cuts to create jobs is not Keynes is to admit that you never read Keynes. I would encourage Bookworm to reacquaint herself with his writings before maligning the great economist or his followers like Blinder.

Charles Martel

“While these schools have declined in the last several decades, the solution is to fix the public schools, not eliminate them.”

What a nice, simple solution: “Fix” them. Of course the how will never, ever be forthcoming.

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Did Obama Really Prevent A Second Great Depression?
By JOHN MERLINE, INVESTOR’S BUSINESS DAILY
Posted 06/20/2011 05:54 PM ET

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It has become a common refrain at the White House and among administration supporters that President Obama’s aggressive efforts to stimulate growth prevented an economic catastrophe.

“We had to hit the ground running and do everything we could to prevent a second Great Depression,” Obama told supporters last week.

Politically, the claim makes sense. Casting the challenge Obama faced as immense can help explain the economy’s lackluster performance in the two years since the recession officially ended.

But is it an accurate portrayal of what really happened?

IBD reviewed records of economic forecasts made just before Obama signed the stimulus bill into law, as well as economic data and monthly stimulus spending data from around that time, and reviews of the stimulus bill itself.

The conclusion is that in claiming to have staved off a Depression, the White House and its supporters seem to be engaging in a bit of historical revisionism.

Economists weren’t predicting a Depression.

White House economists forecast in January 2009 that, even without a stimulus, unemployment would top out at just 8.8% — well below the 10.8% peak during the 1981-82 recession, and nowhere near Depression-era unemployment levels.The same month, the Congressional Budget Office predicted that, absent any stimulus, the recession would end in “the second half of 2009.” The recession officially ended in June 2009, suggesting that the stimulus did not have anything to do with it.The data weren’t showing it, either.The argument is often made that the recession turned out to be far worse than anyone knew at the time. But various indicators show that the economy had pretty much hit bottom at the end of 2008 — a month before President Obama took office.

Of course, the argument now is whether we are really in a recovery, cruising along the bottom, or on the threshold of a double-dip.

The Bush Administration probably averted that catastrophe with TARP. The U.S. and other developed nations have a number of automatic stabilizers that kicked in. But even with the boost of the ARRA, the U.S. economy is in the doldrums. Debt’s not the immediate problem, or rates would be much higher. Rather, demand is still very weak, and investors are still waiting to get back in. Typical recoveries from financial panics can take 5-7 years.

Seems these dislocations are largely due to misreading market signals, and the breakdown is the indication new choices need to be made, a different allocation of resources against needs is needed. Government employees by their definition are either (1) much more able intellects than average or (2) inappropriately compensated for the work they do.
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In either case letting the private sector do these jobs (or not do them if there is no demand) will make better use of these intellects or compensate them more rationally. A large economic gain in either case. So if stimulus is needed feed it thru the private sector (by letting those already successful at creating businesses and jobs keep more of their money, from the very small to the very large, and also remove the hidden costs of unequal regulation – that force non-market based factors into their own choices).
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I don’t understand why/how folks can claim that employment by government (where employees by definition almost always follow a process dictated by law, rather than being able to exercise intellect and judgment as is often needed in the private sector to succeed) has the same economic benefit as work that often has an above the line return in the private sector, but is always a below-the-line cost when done by a government.
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We have the case now where congress spends 10b$ per day, their laws create regulations that direct the spending of another 10b$ per day (i.e. in ways the market would not choose), and congress is borrowing from the future to meet entitlements another 10b$ per day.. which leaves maybe 10b$ per day of free-market activity. No wonder the economy has stalled, and salaries have been stagnant and declining as government directed benefits absorb all middle-class productivity increases (save for those who are spectacularly productive and creative and rise out of the middle-class).

It suggests the existence of a permanent disaffected and chronically unemployed labor class.

Good question is, why is it so high in the U.S. as compared to other countries listed in the graph (presuming, of course, that these numbers are accurate…different countries measure “structural unemployment” differently and I know the numbers in the UK and Belgium, as examples, are astoundingly high).

abc

Danny, the TARP program which included a bailout of the banks occurred earlier than the article cites, and this DID avoid a Great Depression, although many Tea Party types think it was a mistake to bailout the banks. I guess they would have preferred 20%+ unemployment rates… The stimulus, which came later and was far too small to move the needle, was designed to jump start the economy. It hasn’t worked because it was too small. It was less than $1TN, which on a $13TN economy is small. Add to it the fact that about one-third of it was related to tax cuts on people who already have record low tax rates, and you can see why it was less than optimal. Nonetheless, the non-partisan CBO concluded that over 3M jobs were created or saved from this under-funded program. Nothing I read in IBD, including the mistaken unemployment forecasts from the Obama White House changes this. Summers recently vindicated Krugman by noting that a larger stimulus was probably warranted, and I think the facts bear this out.

Ari,

“Seems these dislocations are largely due to misreading market signals, and the breakdown is the indication new choices need to be made, a different allocation of resources against needs is needed. Government employees by their definition are either (1) much more able intellects than average or (2) inappropriately compensated for the work they do.”

Why only those two choices? What about cases in which they need to do work that the private sector cannot (regulatory oversight) or should not (Marines)? It is strange the way you divide the world into these dicotomies. By the way, on the debate over public workers, they are not necessarily more able, but they are more educated, on average, than private sector workers, which is why you have to adjust for education before comparing salaries, which partisan conservatives always fail to do (surprise, surprise…). That is likely why you make the two (false) points that you do here.

“So if stimulus is needed feed it thru the private sector (by letting those already successful at creating businesses and jobs keep more of their money, from the very small to the very large, and also remove the hidden costs of unequal regulation – that force non-market based factors into their own choices).”

Who do you think is doing the existing stimulus? The roads being built and other infrastructure projects have many private firms involved. Fareed Zakaria rightly pointed out that the US should copy Asia (yes, copy best practices outside of its borders–gasp!) and set up an infrastructure bank so that these projects have higher private sector involvement and are allocated based upon economic need rather than political largess. These are good ideas, which Dems and Repubs can agree to. But right now, many conservatives reject all government funding for stimulus even when it goes to private firms.

Also, there is no proof of increased regulation under Obama hurting the economy. Private firms are facing the same regulatory environment that they did under Bush and Clinton, and it is far less strict than it was under Nixon, when the country was growing at much higher rates. This is yet another canard without empirical support from the anti-Obama crowd.

“I don’t understand why/how folks can claim that employment by government (where employees by definition almost always follow a process dictated by law, rather than being able to exercise intellect and judgment as is often needed in the private sector to succeed) has the same economic benefit as work that often has an above the line return in the private sector, but is always a below-the-line cost when done by a government.”

Wow. Our soldiers add no value, exercise no intellect and have no judgment. The people risking life and limb in Iraq and Afghanistan will be happy to hear that from you. There is a requirement for intellect and judgment in public positions, although Bush and his team clearly didn’t exercise it given their budgetary math and military planning… But seriously, economic activity in the public sector on average is less efficient, but not always and certainly not in cases in which there are problems with th private sector doing the work. One such case is when the economy has a crisis of demand and confidence. In that case, the less efficient public work can revive the economy, and thus the trade-off on efficiency is more than acceptable. In other words, there is no crowding out when the private sector isn’t doing anything to crowd out in the first place.

“We have the case now where congress spends 10b$ per day, their laws create regulations that direct the spending of another 10b$ per day (i.e. in ways the market would not choose), and congress is borrowing from the future to meet entitlements another 10b$ per day.. which leaves maybe 10b$ per day of free-market activity. No wonder the economy has stalled, and salaries have been stagnant and declining as government directed benefits absorb all middle-class productivity increases (save for those who are spectacularly productive and creative and rise out of the middle-class).”

Interesting math. We run a $1TN+ deficit on a $13TN economy. The majority (about 61%) of that activity is in the private sector. By your math, the government is spending $3.7TN and borrowing another $3.7TN, which leaves only $3.7TN of private market activity. That implies only 33% of the $13TN is in the private sector, which is not what the official figures show. Better check your facts.

Charles Martel

“Wow. Our soldiers add no value, exercise no intellect and have no judgment. The people risking life and limb in Iraq and Afghanistan will be happy to hear that from you.”

Red herring.

Allen

It’s not often you get to see someone arguing that a perpetual motion machine is possible, but also increases energy in the system. I have often seen the government and the economy from a certain thermodynamic view. The engine. is leaky, needs a tune-up every so often, and requires protection from theft, so some energy must be taken from the system to provide for that. The idea that you can take energy from a system, put it back in, and increase the overall energy output of the system is laughable.

Keynes was not wrong from the standpoint that injecting energy into the system might ameliorate a slow running system. The problem is where do you get the energy from?

Allen: Keynes was not wrong from the standpoint that injecting energy into the system might ameliorate a slow running system.

Interesting analogy, though the water pump is the traditional analogy. In order to get a small engine started, you might pump extra fuel into the chamber. Or put water in a pump to prime it.

Allen: The problem is where do you get the energy from?

With a water pump, from water you saved in the bucket from pumping the last time. With an engine, from your fuel supply. With the economy, either from savings or by borrowing.

Allen: It’s not often you get to see someone arguing that a perpetual motion machine is possible, but also increases energy in the system. That is the common misunderstanding. It’s called countercyclical policy. In terms of a heat engine, it’s called a governor, which regulates the flow in order to keep the engine from running too fast or too slow. http://tinyurl.com/3u8ev56

Ocean Guy

Government spends money… No money no government, unless all govt workers are volunteers and their office space, salaries, communications, and benefits are donated. Government must get the money from someone else. Of course government can also print money to spend.

Private enterprise farms, mines, or creates goods for barter/sale. Using money as the medium for trade, Private enterprise takes one dollar and turns it into something more than a dollar. If not, the enterprise fails… it cannot print it’s own money, it can only farm, mine, or create goods to sell.

Government can take part of what the producers create, and it can print money to fill it’s coffers. But however it does it, one dollar in the coffer, after paying it’s own overhead costs, means there is something less than a dollar to take out of the coffer. As long as the governemnt’s money is recognized as the worldwide currency, the system has the chance to work. But except for the short term, an infusion of money into governemtn coffers is no way to stimulate an economy. Remember a dollar into the coffer means somethign LESS than a dollar available to spend on goods and services. That may stimulate spending for a short time, but it’s a drag on the economy unless Private industry is able to contribute enough to the coffers to overcome the inefficiencies in government in operating and spending.

Priming the pump? Doesn’t work when the well goes dry, a regulator does you no good then.

Our well isn’t dry, yet… But we’ve primed the pump and are running it much faster than the well can replenish itself. We are borrowing from others to keep the pump running and printing more money to dump into the well… which seems a bit silly in the real world. This rickety stool supported by taxes, borrowing, and printing is barely supporting our weight. We’re in deep do do though if the dollar loses it’s position as the world’s reserve currency. As bad as things are now, with the behemoth of government forcing us to borrow and print more and more, it would be disasterous for us if the dollar loses its position.

This Administration, by printing money thus weakening the dollar; and expanding government and it’s inherent inefficiencies are making our problems much worse. Keynesians have show no regard for the fuel/water to keep the pump running. Applying a governeor to the system only affects the rate at which the well gets pumped, it only affects how long it takes the well to go dry.

The bottom line is that without wealth, without increased Private enterprise profits, which will be taxed to refill the well, ALL government spending is unsustainable. YES, some governement is essential, some governemt is beneficial, and some government is nice to have. But today… Government costs too much… it is WAY too big, and is too big a drag on its productive citizens.

Keynes? Nice classroom discussion topic, but the reality is that massive stimulus for governement spending is NOT having the predicted nor desired effects. Once again the reality has fallen short of the theory’s promises. It’s way past time for government to shrink and for the growth in government expenditures to stop… or at least grow more slowly than the economy… IT’s also WAY past time to REMOVE government spending from the GDP.

GOVERNMENT PRODUCES NOTHING. Government only consumes and redistributes, it PRODUCES NOTHING, so why is it part of GDP?

Ocean Guy: But except for the short term, an infusion of money into governemtn coffers is no way to stimulate an economy. Remember a dollar into the coffer means somethign LESS than a dollar available to spend on goods and services.

That’s right. Taxes reduce the amount of money available to the private sector and tend to decrease economic activity. Ocean Guy: Our well isn’t dry, yet… But we’ve primed the pump and are running it much faster than the well can replenish itself.

The U.S. economy is working well under capacity, as seen in the unemployment numbers.

Ocean Guy: We’re in deep do do though if the dollar loses it’s position as the world’s reserve currency.

That will happen eventually, regardless. The U.S. is not the only powerful economy in the modern world.

Ocean Guy: This Administration, by printing money thus weakening the dollar; and expanding government and it’s inherent inefficiencies are making our problems much worse.

Other than the stimulus, which is a short term expenditure, the federal government hasn’t expanded significantly.

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